Boustead Holdings Berhad (KLSE:BSTEAD) Takes On Some Risk With Its Use Of Debt

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' When we think about how risky a company is, we always like to look at its use of debt, since debt overload can lead to ruin. We can see that Boustead Holdings Berhad (KLSE:BSTEAD) does use debt in its business. But is this debt a concern to shareholders?

What Risk Does Debt Bring?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. The first thing to do when considering how much debt a business uses is to look at its cash and debt together.

Check out our latest analysis for Boustead Holdings Berhad

What Is Boustead Holdings Berhad's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Boustead Holdings Berhad had RM7.58b of debt in December 2020, down from RM7.91b, one year before. On the flip side, it has RM497.0m in cash leading to net debt of about RM7.09b.

How Healthy Is Boustead Holdings Berhad's Balance Sheet?

According to the last reported balance sheet, Boustead Holdings Berhad had liabilities of RM7.38b due within 12 months, and liabilities of RM3.49b due beyond 12 months. Offsetting these obligations, it had cash of RM497.0m as well as receivables valued at RM1.88b due within 12 months. So its liabilities total RM8.50b more than the combination of its cash and short-term receivables.

This deficit casts a shadow over the RM1.19b company, like a colossus towering over mere mortals. So we definitely think shareholders need to watch this one closely. After all, Boustead Holdings Berhad would likely require a major re-capitalisation if it had to pay its creditors today.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Boustead Holdings Berhad shareholders face the double whammy of a high net debt to EBITDA ratio (12.2), and fairly weak interest coverage, since EBIT is just 0.69 times the interest expense. The debt burden here is substantial. However, it should be some comfort for shareholders to recall that Boustead Holdings Berhad actually grew its EBIT by a hefty 379%, over the last 12 months. If that earnings trend continues it will make its debt load much more manageable in the future. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Boustead Holdings Berhad will need earnings to service that debt. So if you're keen to discover more about its earnings, it might be worth checking out this graph of its long term earnings trend.

But our final consideration is also important, because a company cannot pay debt with paper profits; it needs cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. Happily for any shareholders, Boustead Holdings Berhad actually produced more free cash flow than EBIT over the last two years. There's nothing better than incoming cash when it comes to staying in your lenders' good graces.

Our View

To be frank both Boustead Holdings Berhad's interest cover and its track record of staying on top of its total liabilities make us rather uncomfortable with its debt levels. But on the bright side, its conversion of EBIT to free cash flow is a good sign, and makes us more optimistic. Looking at the balance sheet and taking into account all these factors, we do believe that debt is making Boustead Holdings Berhad stock a bit risky. Some people like that sort of risk, but we're mindful of the potential pitfalls, so we'd probably prefer it carry less debt. When analysing debt levels, the balance sheet is the obvious place to start. But ultimately, every company can contain risks that exist outside of the balance sheet. To that end, you should learn about the 2 warning signs we've spotted with Boustead Holdings Berhad (including 1 which is potentially serious) .

When all is said and done, sometimes its easier to focus on companies that don't even need debt. Readers can access a list of growth stocks with zero net debt 100% free, right now.

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This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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